What To Watch Out For In A REIT Manager Fee

Singapore Real Estate Investment Trusts (‘S-REITs’) have been a great investment asset class for the past decade. The definition of REIT is a listed vehicle that pools funds from investors to purchase real estate or real-estate related assets. While it has gained tremendous popularity amongst investors, not many realise the importance of Manager fees. In a ceteris paribus situation, a higher Manager Fee will eat into the distributable income of the unitholders.

In this article, Heartland Boy will explain in great detail on:

What type of fees do REIT Managers earn,

What are the industry standards for Manger’s fees,

What actions from the Manager should you watch out for.

This article will also contain a lot of jargon used in the REIT industry, you can refer to this useful list of REIT Jargon to clarify your understanding.

How Are The Sponsor, Manager And Unitholder Related?

First and foremost, unitholders need to understand that there are shareholders who own the REIT Manager. The setup of most REITs and Business Trusts is such that the Sponsor (developer) is usually the shareholder of the REIT Manager. By having a shareholding in the REIT Manager, the Sponsor is entitled to the fees that the Manager earns as shown in Diagram 1.

Diagram 1- Sponsors usually own the REIT Manager and hence receive the fees the Manager collects

A REIT setup is extremely attractive as such fees are usually stable and provides recurring income for the Sponsor. As the profits of property development is very lumpy, developers yearn for a stable recurring income to prevent a feast and famine situation. Like any for-profit company, part of a Manager’s KPI is tied to the fees that it generates for the Shareholder (Sponsor) during the fiscal year. Therefore, the higher the fees, the higher the year-end bonus and increment in salary for the S-REIT Manager. Heartland Boy thinks it is very important to understand this symbiotic relationship between these parties. Such understanding is key to picking better quality REITS in the marketplace.

How Do REIT Managers Earn Their Fees?

Management Fee (Base)

Definition:

Basic fees paid to the Manager of a S-REIT for its role in providing management services such as implementing proactive measures to enhance returns of S-REIT (eg: acquisition, capital markets risk- management)

Current Market Practice:

0.25%- 0.5% pegged to valuation of Deposited Property

10% of Distributable Income

What To Watch Out For:

For base management fees pegged to valuation of deposited property, this implies that the base management fees increase when the valuation of the deposited property grows. Valuation of deposited property can grow in a couple of ways:

Add more properties into the portfolio

Increase the valuation of your individual properties with number of properties remaining constant

For A, unitholder should be mindful whenever the REIT Manager proposes an acquisition. While an acquisition definitely grows the deposited property valuation, it is not a given that it will increase the unitholder’s dividends. One metric to pay attention to would be DPU-accretion. That is, unitholder would benefit from an acquisition that increases the dividend payout of the REIT. Otherwise, unitholder risks getting their dividend yield diluted.

For B, unitholders need to understand that valuation of properties is performed by independent valuers engaged by the Manager/Trustee. Examples of valuers in the market would include Jones Lang LaSalle, CBRE, Colliers etc. One potential red flag to watch out for would be rising property valuations in an environment of falling rents. As counter-intuitive as this sounds, it has occurred before. Such a relationship is somewhat similar to that of rating agencies and banks.

Performance Fee

Definition:

Variable fees paid to the Manager of a S-REIT that serves as an incentive for achieving certain levels of growth.

Current Market Practice:

2.85% of Gross Revenue

3% – 3.6% of the Net Property Income

25% of the difference in DPU between current and preceding year

1% to 0.2% of Deposited Property provided that DPU growth is at least 2.5%

What To Watch Out For:

It is almost a given that any acquisition will increase the Gross Revenue of a REIT. After all, tenants pay rent in a building and this is captured under Gross Revenue. In light of this, increasing the Gross Revenue is an extremely low hurdle to cross for the Manager to receive its Performance Fee.

Along the same vein, Net Property Income is also a relatively easy hurdle to overcome. As long as the proposed building to be acquired generates more rent than the operating expenses (utility, security fees etc) it requires to run it, the REIT Manager will be guaranteed an increase in its Performance Fees.

A genuine alignment of interest with unitholders would be to peg Performance Fee to DPU Growth. This is the truest measure of whether a unitholder has benefited from a Manager’s outperformance.

Acquisition Fee

Definition:

This is a fee paid to compensate and reward the Manager for its effort in completing an acquisition for the REIT.

Real estate is not cheap and usually run up to hundreds of millions. Therefore, it is always good to keep in mind the absolute fees accompanying a proposed acquisition. Here is a fun fact: Did you know that the Manager of ESR Reit stands to make 1% in acquisition fees on the proposed merger with Viva Industrial Trust? Having valued Viva at S$936 million, this is a cool $9.3 million in acquisition fee for the Manager.

Divestment Fee

Definition:

This is a fee paid to compensate and reward the Manager for its effort in completing a sale of a property for the REIT.

Current Market Practice:

0.5% of divestment value

What To Watch Out For:

Even though there is a fee attributed to divestment of a property from the REIT portfolio, this does not happen as frequently as Acquisition due to the following reasons:

Divestment leads to a fall in future DPU if the Manager is unable to expediently replace the loss in rent with new investments

Other Type Of Fees

When managing buildings, several functions such as leasing, property management and project management are required. These are necessary to ensure that a building is well-managed and its capital value optimised. To keep the REIT Manager lean, these services are usually outsourced to third parties. Established developers which possess the expertise and personnel would make use of this opportunity to provide these services to the S-REIT. Viewed in a cynical way, this represents another bite of the cherry for the developers. However, Heartland Boy thinks these types of fees are fair and necessary as genuine services are being rendered. If done well, they will preserve or enhance the value of the real estate.

How Are Management Fees Paid?

Finally, it is important to note whether the Manager fees are paid in units or in cash. Units here refer to units in the REIT, similar to the concept of shares of a stock. If the Manager’s fees are paid in units, it will preserve cash in the current financial quarter as new units will be issued in kind instead. In the next quarter when the REIT distributes dividends to unitholders, the Manager would receive cash as a result of owning units in the REIT just like any other unitholder.

While paying the Manager’s management fee may mean more distribution for the unitholders in the current financial period, do note that an expanding shareholding base will eventually dilute existing unitholders’ DPU down the road. Adjusting the cash to unit ratio of the Manager’s management fees is one of the cards that a REIT Manager can play, so unitholders need to watch out for this.

Conclusion

In order to operate, REIT Manager has to qualify for a license from MAS. It is therefore subject to a strict set of guidelines. However, there is only so much that rules and regulations can do to steer the moral compass towards the right direction. With a better understanding on the type of fees that a REIT Manager receives, Heartland Boy hopes that you will be better placed to evaluate S-REITs in the future.